EMEA perspectives from César Pérez at JP Morgan PB

Ratings agencies, sovereign credit, structural factors and the French presidential election are all contained in the latest thoughts of César Pérez, EMEA chief investment strategies at JP Morgan Private Bank.

In 2011 the US lost its AAA rating for the first time ever. In Europe a number of countries were subsequently downgraded in the context of the euro-zone crisis (January 2012), including France and Austria, which also lost their AAA ratings. Accordingly, understanding and forecasting how rating agencies analyze sovereign creditworthiness has become an increasingly important part of our investment thinking, especially with respect to sovereign bond investments in Europe. European leaders seem to have agreed for now to follow a path of austerity, but this also raises the risk of an economic downturn. In this edition of EMEA Perspectives, we therefore wanted to focus on how rating agencies develop sovereign credit ratings and why France’s rating was downgraded, while Germany’s rating was confirmed at AAA (stable). The French downgrade is particularly interesting given presidential and legislative elections are approaching.

To recap quickly what happened in January: Standard and Poor’s (S&P), one of the three major rating agencies globally, completed its analysis of the sixteen European countries that it had previously put up for review as a result of the Eurozone crisis. Nine Euro area countries were downgraded by one to two notches (see table below). The ratings of the seven remaining countries were affirmed, yet, all but two countries (Germany and Slovakia) were left with a negative outlook, meaning that S&P assigns a one in three chance to a further downgrade of the respective countries over the next 24 months.

What prompted this unprecedented move? At the time, S&P noted that the actions taken by European policymakers had been insufficient to fully address concerns regarding the ongoing systemic stress in the Eurozone as a whole and the periphery in particular. The main concerns included: (1) a reluctance to engage in meaningful policy coordination, (2) tighter credit conditions, (3) increased risk premiums for a widening group of euro-zone issuers, (4) simultaneous attempts to delever by governments and households, and (5) weaker economic growth prospects, especially in the periphery.